Uncertainties over central bank policies take shine off carry trade
Money traders stay on sidelines because they are not confident that the economy will improve
The US$4 trillion-a-day foreign-exchange market is losing confidence in central banks' abilities to boost a struggling world economy.
While small foreign exchange swings historically favour the strategy of borrowing in low-yielding currencies to buy those with higher returns, a UBS index that tracks profits from the so-called carry trade has fallen to the lowest level since 2011.
"At this stage it may feel frustrating, but waiting is not a bad strategy," said Mauricio Bouabci, a currency fund manager in London at Pareto Investment Management, which oversees US$45 billion (HK$348 billion). It would take increased volatility to tempt him back into the market.
Foreign exchange speculation is declining because of mandated spending cuts and tax increases in the US next year, concern that European leaders are not moving fast enough to fix the debt crisis, and slowing growth in emerging economies.
The world economy will expand 3.3 per cent this year, the least since the 2009 recession, the International Monetary Fund said on October 9. Average daily volume in foreign exchange fell 39 per cent in September from a year earlier, according to wholesale broker ICAP. That is also harming currency managers' efforts to boost returns.
The UBS V24 Carry Index climbed 4.55 per cent in the first quarter, the most since 2009, amid optimism the economic recovery was gathering pace. It ended last week at 428.71, down 7 per cent from this year's high of 461.01 set on February 29.
The gauge has fallen 4.8 per cent from 450.15 on August 9, before the Federal Reserve said it would buy US$40 billion of mortgage debt a month until it sees improvement in the economy.
In that time the European Central Bank too said it would buy bonds of indebted members that ask for aid and the Bank of Japan boosted its asset-purchase fund to 55 trillion yen (HK$5.34 billion). The JP Morgan volatility index fell to 7.47 per cent on October 15, the least since 2007.
"Low volatility is something that participants haven't felt comfortable with for a while," Adrian McGowan, head of foreign-exchange forwards, options and trading in Europe at Barclays in London, said on October 12.
Investors have not been making "large" bets "because there has been so much uncertainty", he said. The dollar fell 0.6 per cent against the euro last week to US$1.3024, and rose 1.1 per cent to 79.32 yen as speculation the Bank of Japan will boost monetary stimulus sapped demand for that nation's assets.
Investing the proceeds of dollar-denominated loans should offer easy profits because the Fed has said it is likely to keep the target rate between banks near zero until mid-2015.
The carry trade can lose money when the currency used to fund the strategy strengthens, or the targeted currency weakens, or some combination.
